1. No category

DEVELOPING TRENDS IN
NON-COMPETE AGREEMENTS AND
OTHER RESTRICTIVE COVENANTS
Angie Davis, Eric D. Reicin1 and Marisa Warren
American Bar Association
Section of Labor and Employment Law
8th Annual Labor and Employment Law Conference
Los Angeles, California
November 6, 2014
1
The views expressed in this document are of the authors and not necessarily of those of MorganFranklin Consulting,
LLC. Further, the document is intended to serve as a current discussion of the law, a vehicle for further conversation
during the ABA panel, and not necessarily the personal views of its authors.
DEVELOPING TRENDS IN NON-COMPETE AGREEMENTS AND OTHER
RESTRICTIVE COVENANTS
By: Angie Davis, Eric D. Reicin2 and Marisa Warren
Covenants not to compete are a common vehicle for protecting a company’s proprietary
and confidential information and trade secrets. From the employer’s perspective, the loss of key
employees, customer lists, price lists, customers, confidential information, or trade secrets can
damage a Company. From the employee’s perspective, non-competition agreements can limit an
employee’s ability to find future employment or utilize various pieces of information or contacts
gained during employment. In dealing with these issues, courts typically strike a balance between
the employer’s need for protection on one hand and an employee’s right to work for a different
employer on the other. Knowing this, it is important for employment lawyers to have a firm
understanding of non-compete agreements and other restrictive covenants, which are subject to
complex and ever-changing legal schemes both within and outside of the United States. This paper
discusses developing legal trends in restrictive covenants, including best practices for negotiating
restrictive covenants and defenses to enforcement of restrictive covenants. It also explores several
emerging issues, such as the employee choice doctrine/forfeiture issues, choice of law, nonpoaching agreements, and enforcement of restrictive covenants outside of the United States.
2
The views expressed in this document are of the authors and not necessarily of those of MorganFranklin Consulting,
LLC. Further, the document is intended to serve as a current discussion of the law, a vehicle for further conversation
during the ABA panel, and not necessarily the personal views of its authors.
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Part One: Best Practices for Negotiating Restrictive Covenants
Although courts typically disfavor restrictive covenants because they restrain competition
and are often unduly burdensome on an employee’s right to earn a living,3 in most states, 4 courts
will enforce these restrictive covenants if the covenant protects a legitimate business interest, the
employee received consideration for the covenant, the covenant is narrowly tailored, and the time
and territorial limitations are reasonable no greater than necessary to protect the business interest
of the employer.5 Although there are some common trends, no two states treat restrictive
covenants exactly alike, and, therefore, before drafting or enforcing restrictive covenants, one must
conduct state-specific research. The following summarizes the tests that most states employ.
A.
How far should your geographic restrictions reach?
With respect to the reasonableness of geographic limitations, an evolving issue is whether
a customer restriction may substitute for a geographic limitation.
Imagine that your client, a company, has a salesman who has ten key accounts in seven
different states, and your client wants to protect those accounts and try to maintain them within
the company. A multi-year covenant not to compete, covering all seven states, may be too broad
and thus unenforceable. Therefore, the better answer in many jurisdictions is to draft a covenant
that prohibits the salesperson from soliciting customers that she had meaningful contact with
during the last one year of her employment for a period of, say, two years after termination. Most
states will allow for a customer restriction in lieu of a geographic scope. However, in certain
3
McGlothen v. Heritage Environmental Servs., LLC, 705 N.E.2d 1069, 1071 (Ind. Ct. App. 1999) (“Generally,
covenants not to compete are disfavored by law because they restrain trade.”); See e.g., Murfreesboro Medical Clinic,
P.A. v. Udom, 166 S.W.3d 674, 678 (Tenn. 2005). See Brian M. Malsberger, Covenants Not to Compete: A State-byState Survey (9th ed. 2013).
4
Id. But see, state statutes in California (Cal. Bus. And Prof. Code Section 16600, 16601, 16602, and 16602.5),
Oklahoma (Okla. Stat. Tit. 15, 219A), and North Dakota (N.D. Cent. Code Section 9-08-06.).
5
Id. Currently, at least 21 states have at least one state statute governing employee non-competes, but even with those
state statutes, it is important to review the evolving common law case law on the subjects.
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states—namely, Louisiana and South Dakota—courts will not enforce such a covenant because it
lacks a geographic limitation.6 Other states such as Florida, Kentucky, Nevada, New Hampshire,
Oklahoma, Rhode Island, and Wyoming have not yet addressed whether a customer restriction
may substitute for a geographic limitation. This creates uncertainty and, in turn, increased risk.7
B.
What should you consider when it comes to consideration?
Like any other contract, a non-compete agreement must be supported by adequate
consideration, i.e., a bargained-for exchange. As a general rule, consideration for a contract may
be either: (1) a benefit to the promisor; or (2) a detriment to (or an obligation upon) the promisee.8
In many states, continued or initial employment is sufficient consideration for a restrictive
covenant agreement. However, several states have reached a contrary conclusion. Those states—
Connecticut, Kentucky, Minnesota, Montana, North Carolina, Oregon, Pennsylvania, South
Carolina, Texas, Washington, West Virginia, Wisconsin, and Wyoming—reason that continued
employment, without more, is not sufficient consideration because the employee/promisor is
incurring an obligation (not receiving a benefit) and the employer/promisee is receiving a benefit
(not incurring an obligation).9 Other states such as Alaska, Hawaii, New Mexico, and Oklahoma
have not explicitly addressed whether continued employment is sufficient consideration.10
Accordingly, in quite a few states, an employer that hopes to enter a restrictive covenant agreement
6
See Brian M. Malsberger, Covenants Not to Compete: A State-by-State Survey (9th ed. 2013).
7
Id.
8
Omaha National Bank v. Goddard Realty, Inc., 316 N.W.2d 306, 310 (Neb. 1982) (“There is a sufficient
consideration for a promise if there is any benefit to the promisor or any detriment to the promisee.”).
9
See Brian M. Malsberger, Covenants Not to Compete: A State-by-State Survey (9th ed. 2013).
10
Id.
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with an existing employee must offer more than just continued employment. Again, state-specific
research is, therefore, crucial.11
Part Two: Other Provisions Often Included in Restrictive Covenants
A.
What jurisdiction’s laws will apply?
Although most courts recognize the parties’ abilities to choose the law they would like to
govern their agreement, such as a recent well publicized case in Texas,12 two separate New York
courts recently rejected express choice-of-law provisions in this area, ruling instead to apply New
York law to the subject agreement. In Brown & Brown v. Johnson, the court acknowledged that a
choice of law provision will generally be enforced in order to effectuate the intent of the parties if
the chosen law bears a reasonable relationship to the parties or transaction.13 However, the chosen
law must not be “truly obnoxious” to New York’s public policy.14
The court found that Florida law bore a reasonable relationship to the parties and
transaction, but that the law differed too vastly from the policy underlying New York’s treatment
of restrictive covenants. In New York, restrictive covenants are disfavored and are enforced only
to the extent necessary to protect the legitimate interests of the employer, if the restrictive covenant
is not unduly harsh or burdensome to the employee and is not injurious to the public. Thus, a
covenant that imposes an undue hardship on an employee is unenforceable. By contrast, Florida
law expressly forbids courts from considering hardship to an employee in evaluating the
Among other important topics, whether reformation or “blue penciling” by a court is permitted or a preferred
approach also is state specific. Several states such as Oklahoma, Virginia, and Nebraska do not permit blue penciling.
Management law firm Seyfarth Shaw recently put together an in-house counsel client friendly 50 state survey on many
of the issues. Seyfarth Shaw 50 State Desktop Reference, 2014-2015 Edition. It can be publicly accessed at:
http://www.seyfarth.com/uploads/siteFiles/practices/141926_ChartofTradeAgreementsbyState_FINAL.pdf
(most
recently accessed on September 26, 2014).
11
12
See, e.g., ExxonMobil Corp. v. Drennen, No. 12-0621, 2013 WL 9600951 (Tex. Aug. 29, 2014) (New York choice
of law applied in Texas case).
13
115 A.D.3d 162 (4th Dept. 2014).
14
Id.
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reasonableness of a restrictive covenant. Florida courts are required to construe covenants in favor
of the party seeking to protect its business interests. Based on these substantial differences, the
New York court found that Florida’s treatment of restrictive covenants was “truly obnoxious” to
New York’s public policy and rejected the choice of law provision. Notably, on May 2, 2014, an
appeal was taken in the Brown & Brown case, and so New York’s highest court, the Court of
Appeals, will soon weigh in on this issue.
Along the same lines, a fellow appellate court in New York rejected a Delaware choice of
law provision.15 Even without a finding that the underlying policy in Delaware differs significantly
from that of New York, the court, without analysis, elected to apply “the law of New York, the
forum state.”16 These cases illustrate how closely judges in one state may scrutinize restrictive
covenants according to the principles developed within their own jurisdiction, as well as their
willingness to disregard provisions calling for a conflicting approach.
B.
Is everything confidential or only trade secrets?
For those advising employees and employers alike, confidentiality agreements can be a
trap for the unwary and should be reviewed carefully for scope and duration under applicable state
law. A few states impose time and scope restrictions on certain non-disclosure agreements. For
example, a Florida statute provides that “[i]n determining the reasonableness in time of a postterm restrictive covenant predicated upon the protection of trade secrets, a court shall presume
reasonable in time any restraint of 5 years or less and shall presume unreasonable in time any
restraint of more than 10 years.”17 Wisconsin likewise requires employers to limit non-disclosure
15
TBA Global LLC v. Proscenium Events, LLC, 114 A.D.3d 571 (1st Dept. 2014).
16
Id.
17
Fla. Stat. Ann. § 542.335.
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agreements.18 However, Wisconsin employers need not limit confidentiality agreements covering
information that qualifies as a trade secret.19
Accordingly, one solution is a bifurcated
confidentiality agreement, i.e., one that defines both “confidential information” and “trade secret”
and limits the former, but not the latter. In any event, one should not assume that confidentiality
agreements are immune from the rules governing restrictive covenants.
In most cases, the determination of whether information is a “trade secret” is usually
decided under state law and often using the Uniform Trade Secrets Act (UTSA) as a model.20
As of the date of this paper, the U.S. Congress is considering whether to “federalize” trade
secret law.
The U.S. House of Representatives’ Trade Secrets Protection Act (H.R. 5233
introduced in July 2014), and the U.S. Senate’s Defend Trade Secrets Act (S. 2267 introduced in
18
Tatge v. Chambers & Owen, Inc., 579 N.W.2d 217, 222 (Wis. 1998).
19
Nordson Corp. v. Thomas, 406 N.W.2d 170 (Wis. Ct. App. 1987) (“We do not hold that there may never be a
nonspecific time limitation. True trade secrets, like the Coca-Cola formula, may remain trade secrets until they need
no longer be secret.”).
All but three states (New York, Massachusetts, and North Carolina) have adopted some version of the Uniform
Trade Secrets Act. While one of the intents of the Uniform Trade Secrets Act was to promote uniformity among the
states, those representing plaintiffs in misappropriation of trade secret cases may file a wide range of alternative
common law claims (such as breach of fiduciary duty, confidence, or contract, intentional interference with contracts,
conversion, unfair competition, promissory estoppel, and civil and/or criminal theft) to bolster their cases. Of those
47 states that have thus far adopted the UTSA, 44 have adopted the UTSA express preemption provision, Section 7(a),
which many believe is intended to preempt most common law claims (Iowa, Nebraska, and New Mexico have not yet
adopted Section 7(a)). Even with such adoption, there appears to be a split regarding the scope of such preemption.
The minority approach advocates a narrow application of preemption, to the extent they are based upon additional or
slightly different facts than the trade secret misappropriation claims. The result is that common law claims survive in
the alternative should a court not find the alleged “misappropriated” information rising to the level of a trade secret,
but protectable under an alternative claim. See e.g., Orca Commc’ns Unlimited, LLC v. Noder, 233 Ariz. 411, 420
(Ariz. Ct. App. 2013) (only trade secret information is preempted); Stone Castle Fin., Inc. v. Friedman, Billings,
Ramsey & Co., 191 F. Supp. 2d 652, 659 (E.D. Va. 2002). The majority approach is to apply the Section 7(a)
preemption fairly broadly to preempt all alternative civil tort claims that are predicated on the same nucleus of facts
as a misappropriation of trade secrets UTSA claim. See, Angelica Textile Servs., Inc. v. Park, 220 Cal. App. 4th 495,
507 (2013) (applying California CUTSA); Diamond Power Int’l v. Inc. v. Davidson, 540 F.Supp. 2d 1322, 1345 (N.D.
Ga. 2007) (applying Georgia GTSA). Whether information that does not constitute a trade secret under the UTSA
(and its state law equivalents) is still protected in ways that do not result in UTSA preemption is a development of the
law that practitioners in the employment law arena should keep an eye on during the next few years. Compare, Silvaco
Data Sys.v. Intel Corp., 184 Cal. App. 4th, 210 (2010) with SunPower v. SolarCity Corp., 2012 U.S. Dist LEXIS
176284 at *13 (N.D. Cal. December 11, 2012) (discussing whether propriety information that does not rise to the level
of a trade secret is protectable via contract). For more information on this particular subject, the authors recommend
Bradford K. Newman’s recently published legal treatise, Protecting Intellectual Property in the Age of Employee
Mobility: Forms and Analysis (American Law Media 2014), which goes into far greater detail on these evolving
concepts.
20
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April 2014) have the support of several global companies as well as bipartisan support.21
The
legislation would allow for private civil lawsuits under the Economic Espionage Act, which
currently provides for criminal trade secrets cases only when filed by government prosecutors.
Part Three: Defenses to Enforcement of Restrictive Covenants
Outside of the executive employment agreement and sale of business or practice context,
restrictive covenant agreements are often entered into with very little, if any, negotiation between
the employer and employee. The covenants are usually included in the new hire paperwork or part
of a written employment agreement or offer letter and must be signed as a condition of
employment. Restrictive covenant agreements should be reviewed carefully. When the employee
leaves the company, the restrictive covenant agreement may be an obstacle to future employment
and could potentially prevent the employee from engaging in certain work. Again, courts are likely
to uphold a restrictive covenant agreement if it is reasonable in scope and duration and protects a
legitimate interest of the employer. Although legal defenses vary among states, in many states
there are several common defenses to the enforcement of restrictive covenants. States also vary
substantially as to whether a court will blue pencil or otherwise modify a restrictive covenant
agreement; for example, compare Virginia (which will not blue pencil) with North Carolina (which
recently ordered a lower court to blue pencil).22
A.
Is your agreement too broad in terms of scope or duration?
To be enforceable, a restrictive covenant agreement usually must provide a time and
geographic restriction. The duration of the agreement will be treated on a case-by-case basis. In
On September 17, 2014, the House Judiciary Committee reported out the Trade Secrets Protection Act, HR 5233,
setting up a full House vote on the bill. As of the date of this paper, although debated by the Senate Judiciary
Committee in September, 2014 that committee has yet to take formal action.
21
22
See, e.g., Beverage Systems of the Carolinas, LLC v. Associated Beverage Repair, LLC, Ludine Dotoli and Cheryl
Dotoli, COA14-185 (N.C. Ct. App. August 5, 2014) (requiring blue penciling).
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general, agreements extending beyond one or two years will be scrutinized more closely in most
states particularly when it does not involve the sale of a business. 23 Many jurisdictions often
require a limitation to geographic scope such as a region, state or even a particular mile-radius
from the employee’s location. For instance, if an employer targets a particular market, courts
may refuse to enforce covenants that extend beyond that market. The boundaries of a market,
however, are increasingly more difficult to calculate with today’s global economy and with
the rise of e-commerce.
B.
Are you sure you have a protectable interest?
A restrictive covenant will only be enforceable if it is reasonably necessary to protect the
employer’s legitimate confidential and proprietary interests. Accordingly, a court will only
uphold a restrictive covenant agreement where the departing employee poses a risk of disclosure
or use of confidential information. When drafting restrictive covenants, the exact interests that
are to be protected should be clearly set forth to ensure enforceability.
Similarly, if the restrictive covenant is seen as unfairly restraining all competition over a
former employee, the restrictive covenant agreement often will not be upheld. Among others,
legitimate protectable interests for an employer include goodwill and customer relationships,
client contact information, and an employee’s unique skill or knowledge.
C.
Have you waived your rights to enforcement?
When an employer declines to enforce a restrictive covenant agreement against a former
employee who left to compete, some courts will find that it cannot enforce the agreement against
later departing employees. However, this defense is rarely successful because, to prove this
See section V. A. of this paper for further discussion of the recent corporate use of extended vesting and/or forfeiture
provisions in equity plans, long term incentive plans, bonus plans, severance agreements, and/or ERISA benefit plans
to extend the duration beyond the typical one or two year period.
23
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defense, the employee must show that the waiver was “clear, unequivocal, and decisive,” which is
difficult to prove.24 A business may have many reasons not to enforce a restrictive covenant
agreement. So, often courts hold that a company’s decision not to enforce in one situation should
not have any impact on enforcement against another employee in the future.25
D.
Has a material change impacted your ability to enforce?
The so-called “material change doctrine” holds that a material change in an employee’s job
can operate to void any existing restrictive covenant between the employee and the employer.26
This defense, which had not been used in many years, is seeing resurgence as an argument in
Massachusetts.
In 2012, for example, three Massachusetts trial court judges ruled that pre-existing
restrictive covenant agreements were voided by subsequent material job changes. Two of those
decisions, Grace Hunt IT Solutions, LLC v. SIS Software, LLC, and Protégé Software Services,
Inc. v. Colameta, involved materially adverse changes to the employees’ compensation structure.27
Also, in Grace Hunt, the employees had been asked to sign new restrictive covenant
agreements at the time of the changes but refused. The court found the employee’s refusal to sign
significant because it showed that the old employment relationship had ended. In these decisions,
the courts focused on whether there had been a material job change and not whether the change
was positive or adverse for the employee.
24
Custom Hardware Eng’g & Consulting, Inc. v. Dowell, 2013 U.S. Dist. LEXIS 8904 (E.D. Mo. Jan. 23, 2013).
25
See Gleeson v. Preferred Sourcing, LLC, 883 N.E.2d 164 (Ind. Ct. App. 2008). Contra, Ally Financial v. Sandra
Gutierrez and Homeward Residential, 13-00108-CV, 2014 WL 261038 (Tex. Ct. App. Jan. 23, 2014) (non-compete
and non-solicit contained in long term equity compensation incentive plan, employer failed to enforce; court
determined that inconsistent action in enforcing the agreement can render those agreements unenforceable).
26
See F. A. Bartlett Tree Expert Co. v. Barrington, 353 Mass. 585, 586, 233 N.E.2d 756, 757 (1968).
27
See Grace Hunt IT Solutions, LLC v. SIS Software, LLC, SUCV201200080BLS1, 2012 WL 1088825 (Mass. Super.
Feb. 14, 2012); see also Protégé Software Servs., Inc. v. Colameta, CIV.A. 09-03168, 2012 WL 3030268 (Mass.
Super. July 16, 2012).
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In contrast, in Sentient Jet, LLC v. Mackenzie, the defendant-employees signed restrictive
covenant agreements and thereafter changed positions on several occasions. Unlike Grace Hunt,
however, the employees’ pay increased. The court found that the changes were not “material”
changes that rendered the non-compete agreements void because the employee had not suffered a
loss of income.
E.
Does your prior breach prevent enforcement?
An employee may be able to attack the enforceability of a non-compete agreement where
an employer has breached the agreement.28 Typically, if the employer is the first to violate the
terms of the agreement, employees will argue that the company cannot later seek to enforce the
benefits of that agreement. For employees making this argument, it is vital to determine whether
a material breach occurred as in that the breach goes to the root of the agreement between the
parties.
F.
Do you have enough (or sufficient) consideration?
As discussed above, most states hold that continued employment is sufficient
consideration. However, a minority of states require additional independent consideration beyond
mere employment. Moreover, some courts, such as those in Illinois, may consider the length of
employment following execution of the restrictive covenant agreement to determine whether the
consideration was “illusory.”29 For that handful of states, offering incentives such as bonuses,
equity, participation in certain benefit plans, or severance packages increases the likelihood of
enforceability.
28
See Colucci v. Kar Kare Auto. Grp., Inc., 918 So. 2d 431, 434 (Fla. Dist. Ct. App. 2006); see also Supermarket
Merch. & Supply, Inc. v. Marschuetz, 196 S.W.3d 581, 583 (Mo. Ct. App. 2006).
29
See Lawrence & Allen, Inc. v. Cambridge Human Resources Group, Inc., 685 N.E.2d 434, 442 (Ill. Ct. App. 1997).
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Part Four: Enforcing Restrictive Covenants Abroad
As if juggling the laws of each state is not enough, the global economy is such that large
employers often seek restrictive covenants that are enforceable in other countries, and laws vary
drastically from country to country. For example, in the United Kingdom, restrictive covenants,
such as covenants not to compete, are generally viewed as a restraint of trade.30 A covenant not
to compete must be reasonably necessary to protect a legitimate business interest, reasonably
limited to a certain geographic area, and reasonably limited in duration.31 In comparison to U.S.
courts, UK courts are less likely to enforce a non-compete covenant.32 One author explained that
“the UK courts have upheld a 12-month restriction as being reasonable in certain circumstances
but suggested it would be very unlikely that restrictions longer than 12 months would be
enforceable.”33 Accordingly, many UK employers rely on “garden leave” provisions, which are
generally enforceable.34 The terms of a standard “garden leave” provision require an employee to
give notice several (six to twelve) months before leaving to work for a competitor.35 During that
period of time, the employee is paid but does not work and, in turn, does not compete or have
access to confidential information.36 Although they are expensive, “garden leave” provisions are
likely to be enforced and, in the end, prevent competition for a significant amount of time.
30
Mark
S.
Pulliam
et
al.,
Working
World:
Global
Non-Compete
http://www.lexology.com/library/detail.aspx?g=6dd69807-d197-4d64-82f8-628fcce3b979.
31
Id.
32
Id.
33
Id.
34
Summary,
Wendi S. Lazar, Confidentiality, Trade Secret and Other Restrictive Covenants in a Global Economy (ABA 2010),
http://apps.americanbar.org/labor/intlcomm/mw/papers/2010/pdf/lazar.pdf. This method and is often set out in a more
formal employment agreement prior to job separation. Compared to the United States, it is far more common for
“rank and file” employees in the UK to have formal employment agreements identifying garden leave.
35
Id.
36
Id.
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Other European countries have different legal schemes. In France, a covenant not to
compete is unenforceable unless the employee is paid as much as two-thirds of his former monthly
salary during the non-compete period.37 Additionally, the covenant must be reasonably necessary
to protect a legitimate business interest, reasonably limited to a certain geographic area, and
reasonably limited in duration.38 Stated differently, a covenant not to compete must not prohibit
an employee from engaging in his or her chosen profession. In Germany, a covenant not to
compete must meet the traditional requirements—reasonably necessary to protect a legitimate
business interest, reasonably limited to a certain geographic area, and reasonably limited in
duration—and the employer must “pay . . . compensation throughout the duration of the restriction
equal to at least one-half of the employee’s most recent contractual remuneration at termination
(including all parts of salary and monetary benefits in addition to base salary).”39
Japan takes a similar approach. As a general rule, restrictive covenant agreements are
unenforceable unless the employee receives significant compensation (often as much as fifty
percent of his annual salary).40 That said, “payment may only be required when the restrictive
covenant did not exist during the term of employment but rather was created upon termination.”41
When determining whether a covenant not to compete is enforceable, Japanese courts balance the
employer’s legitimate business interest, if any, and the employee’s right to work. Specifically,
they consider the employee’s position, the activities that are prohibited, the duration of the
37
Mark
S.
Pulliam
et
al.,
Working
World:
Global
Non-Compete
Summary,
http://www.lexology.com/library/detail.aspx?g=6dd69807-d197-4d64-82f8-628fcce3b979. There are several other
matters to consider in France. For example, French law requires all communications with employees to be rendered
in and executed in the national language.
38
Id.
39
Id.
40
Wendi S. Lazar, Confidentiality, Trade Secret and Other Restrictive Covenants in a Global Economy,
http://apps.americanbar.org/labor/intlcomm/mw/papers/2010/pdf/lazar.pdf.
41
Id.
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obligation, its geographic scope, the amount of compensation the employer pays for the covenant,
and any other relevant facts.42
A choice-of-law provision might help one avoid the restrictions outlined above, but then
again, it might not. The European Union takes the position that a choice-of-law provision is
unenforceable if it is “manifestly incompatible” with the public policy of the forum.43 For example,
a French court might ignore a provision stating that US law governs a restrictive covenant if it is
incompatible with French law, which, for example, requires the employer to pay a significant
portion of the employee’s salary during the non-compete period. In Duarte v. Black and Decker
Corp., a UK court refused to recognize a choice-of-law provision applying Maryland law to a
covenant not to compete because enforcement of the covenant would have run afoul of UK public
policy concerning non-compete agreements.44 In sum, every country has different rules governing
restrictive covenants, and choice-of-law provisions are not cure-all solutions, which highlights the
importance of diligent research prior to drafting.
In addition to choice of law, the forum in which the litigation may be brought appears to
be evolving as well. EU Regulation 44/2001, requires employers to litigate claims related to
individual employment contracts only in courts in the country where the employee lives. Some
are starting to argue that this may trump arbitration agreement. We will see how this evolves in
the coming years.
42
Id. Compare with China (China’s rules appear to be evolving and evolving differently in several geographic regions
of the country.).
43
Id.
44
Duarte v. Black & Decker Corp., Case No. HQ07X02401, 2007 WL 4190497 (Nov. 23, 2007) (UK).
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Part Five: New Trends in the Area of Restrictive Covenants
A.
What are forfeiture clauses and “employee choice” principles?
Another evolving issue relates to forfeiture clauses as an alternative means for employers
to deter competition when an employee voluntarily leaves the employer.
Employers are
increasingly using such clauses as a way to obtain broad protections even in those states that are
hostile to non-competition agreements. Typically, these clauses are used in stock agreements,
incentive plans, profit sharing plans, ERISA plans, and other executive compensation plans. They
use extended vesting or clawbacks if the employee breaches a restrictive covenant, like a
confidentiality, non-competition, or non-solicitation covenant. While a majority of states appear
to review these matters under restrictive covenant statutes or common law principles related to
restrictive covenants,45 a handful of states recognize the “employee choice principle.” Under the
“employee choice principle,” the clawback or forfeiture is deemed an “employee choice” of losses
and benefits and not a prohibition on the employee engaging in competitive work. 46 Thus, the
employee can choose to go work for a competitor and forfeit his stock or remain loyal to his
employer and retain the stock. Given this state specific view of the “employee choice principle,”
choice of law provisions, and how courts interpret those choice of law provisions are quite
important. See, e.g., ExxonMobil Corp. v. Drennen, 2013 WL 9600951 (Tex. Aug. 29, 2014)
(applying New York law in Texas case overturning Texas appellate court; case related to
approximately $5M worth of company equity shares).47
45
See e.g., Deming v. Nationwide Mut. Ins, Co., 905 A.2d 623, 638 (Conn. 2006).
46
See e.g., International Business Machines Corp. v. Martson, 37 F. Supp. 613 (S.D. N.Y. 1999 (stock option
agreement with no geographic restriction and forfeiture clause upheld); Morris v. Schroder Capital Mgmgt. Int’l, 7
N.Y3d 616 (N.Y. App. 2006) (employee choice doctrine in NY); W.R. Berkley Corp. v. Hall, 04V-23-246WCC, 2005
WL 406348 (Del. Super. October 13, 2004) (Delaware upholding forfeiture clause).
47
Given the preemption of state law in ERISA plans, one might be able to avoid this issue if the clawback is placed
in such an ERISA retirement plan document. See, e.g., Thomas v. Bostwick, 2014 WL 4364816 (N.D. Cal Sept. 3,
2014). The authors expect the law to evolve in this area in the next few years.
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B.
No Poaching Agreements: Apple, Google, and What You Need to Know
Along with the tech boom, employers have gotten creative in expanding their control over
their employees beyond utilizing traditional restrictive covenant agreements. Employers entering
into and utilizing no poaching agreements has garnered much attention recently.
Unlike traditional restrictive covenant agreements which are entered into between an
employer and an employee, no poaching agreements are entered into between employers, cutting
the employee out of the equation altogether. The development of this practice was stealth,
originating with Apple’s then-CEO, Steve Jobs, directly contacting Google’s then-CEO, Eric
Schmidt, to discuss Google’s pirating of Apple’s employees. The practice spread to other large
technology companies, and the parties agreed amongst themselves to the following restrictive
practices: (1) Not to cold-call each other’s employees; (2) To notify each other when making an
offer to an employee of the other company even if that employee applied for a job on his or her
own initiative; and (3) That any offer would be final and would not be improved in response to a
counter-offer by the employee’s current employer.
This practice has garnered the attention of the U.S. Department of Justice, and it recently
investigated agreements entered into between several high profile technology companies on the
basis that these restraints on employee recruitment and hiring are violations of anti-trust laws.
While appellate courts have not yet been called upon to rule whether these agreements are per se
illegal, several lower court rulings clearly indicate that employers should seek appropriate counsel
on the issue. For example, in denying a motion to dismiss in an action against eBay, the district
court found that the agreement, if proven as alleged, would constitute a naked and horizontal
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“market allocation agreement” that was “manifestly anticompetitive” and “lacking in any
redeeming value.”48
More recently, a federal court in California rejected a proposed $324.5 Million settlement
of a class action suit against Adobe, Apple, Google, Intel, Intuit, Lucasfilm, and Pixar. U.S.
District Court Judge Lucy H. Koh of the Northern District of California criticized the figure for
being too low. She reasoned that based on settlements previously reached prior to attaining class
action status, the parties should be considering a settlement of at least $380 Million. A joint status
update put out by the parties stated that they have resumed mediation. The Defendants also have
sought reversal of Judge Koh’s ruling in the Court of Appeals for the Ninth Circuit.49 Of course,
it should come as no surprise to practitioners that these no poaching agreements were made in
California—where restrictive covenant agreements are extremely difficult to enforce.
During the U.S. Department of Justice’s investigation into the tech company’s suit noted
above, it found emails disclosing Walt Disney, Pixar, and other animation studios similar no
poaching agreements.50 George Lucas testified that the purpose of a non-solicitation agreement
was to suppress wages and keep the visual effects industry out of “a normal industrial competitive
situation.’” “The agreement was explicitly intended to avoid ‘a bidding war with other companies
because we don’t have the margins for that sort of thing.’”
No poaching agreements have been scrutinized in other states. Rather than viewed as an
unlawful restraint of trade, courts have subjected them to a typical “restrictive covenant” analysis.
48
U.S. v. eBay, Inc., 968 F. Supp. 2d 1030 (N.D. Ca. 2013).
49
In re High-Tech Employee Antitrust Litigation, Case No. 11-cv-2509-HLK (N.D. Cal. 2014).
50
Nitsch v. DreamWorks Animation SKG, Inc., No. 5:14-cv-04062 (N.D. Cal. Sept. 8, 2014). In addition to executive
conversations, the complaint alleges that there were emails and meetings among human resource professionals at the
various companies to set certain terms and conditions of employment, particularly those relating to compensation and
raises. On September 23, 2014, upon motion, this case was reassigned to U.S. District Judge Koh as a related case to
the In re High-Tech Employee Antitrust Litigation matter discussed above.
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In Reed Elsevier, Inc. v. TransUnion Holding Company, Inc., Reed Elsevier and TransUnion
entered into an agreement restricting TransUnion’s right to hire Reed’s senior management for a
period of time.51 Reed’s Chief Technology Officer joined TransUnion and Reed sued, alleging a
violation of this agreement. U.S. District Judge P. Kevin Castel of the Southern District of New
York stated that the same “reasonable” test that applied to restrictive covenant agreements (i.e.,
that the agreement must be reasonable in time and duration, necessary to protect the employer’s
legitimate interest, not harmful to the public, and not unreasonably burdensome to the employee)
applies to non-hire agreements between two entities. The court expressed concerns about the two
year no-hire window, yet the court focused on the “legitimate interest” being protected by the
employer. Judge Castel concluded that simply being a member of a company’s senior management
team did not mean the employee had knowledge or possession of a company’s proprietary trade
secrets, was likely to lure away clients, or had provided unique or extraordinary services to the
prior company. The court also made clear that the risk of employee attrition is not a protectable
interest the court will recognize.
Part Six: Final Thoughts
Non-compete agreements and other restrictive covenants are subject to complex and everchanging legal schemes both within and outside of the United States. An awareness of the rules
of the relevant jurisdiction is essential. The question of whether an agreement enforceable, often
turns on what law the court will apply.
Experienced practitioners should narrowly tailor the
agreements to protectable interests and keep an eye on the need to revisit such agreements if
circumstances change in the law or the individual provides services for the organization in a
different capacity or geographical region.
51
13 Civ. 8739 (S.D.N.Y. Jan. 9, 2014).
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